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Tuesday, July 9, 2013

Consumer Adjusted Oil Prices Hit $120

by Lance Roberts

The sweltering summer temperatures aren't the only thing heating up this summer. Oil prices have been surging over the past month as tensions in the Middle East have fostered a breakout of a long term consolidation pattern as shown in the chart below.

Today, more now than ever, we are barraged with economic data; most of which is lost on the average person. One data point, however, that everyone understands is the price of oil as it directly impacts us where it counts the most - the wallet. The price of oil cannot be escaped as it is plastered just about everywhere from being discussed in the financial media, headlines in newspapers or on the internet. However, ultimately, we see it at the gas pump. Oil prices affect us every day in more ways than just what we are paying for gasoline; it also affects everything that we wear, consume or utilize from hard products to services due to rising input costs, fuel surcharges, etc.

This is one reason that when the government reports the consumer price index (CPI), and then strips out food and energy to report "core" inflation, it almost always elicits a negative response. "Main Street" America is directly impacted by two factors when it comes to energy: 1) price changes in the things that they consume; and 2) changes to their personal incomes after taxes. The reason that the "average American" can't grasp things like "core" inflation is because they live in a world where their daily lives are affixed to the disposable personal income they bring home versus the fixed and variable costs of maintaining their lifestyle.

While there has been much pandering about high oil prices - what is more important to note is how these price increases in oil "feel" to the average American. The thing that the Fed misses, in my opinion, is that the average "American" is dealing with a lot rising cost pressures that aren't necessarily included in the inflation calculation. Furthermore, while prices of things like oil, commodities, college costs, insurance, health care, etc. have been rising; disposable personal incomes have been falling. Therefore, each price increase that occurs subsequently has a larger net effect on the limited amount of disposable personal incomes available to the consumer.

This is why most consumer polls show that consumers "feel" like we are still in a recession. To those individuals a recession is equivalent to not being able to make ends meet at home. This is specifically why we are seeing such a lack of final demand from the consumer by small businesses. This defensive position was witnessed in the June jobs report which showed increases in temporary hires and reductions in full time employment.

Since oil prices are a direct cost into so many different aspects of the daily lives of the average "American" - price spikes in oil have a very real impact on the way that consumers "feel" about their ability to make ends meet.

What we find is that when oil prices spike there is an immediate shock to the disposable personal incomes for individuals. For example, during the Iran crisis oil peaked at $115.90 per barrel for consumers, however, it "felt" like $255. Then at the peak of the oil market in 2008 when oil traded for $145.02 a barrel it felt much closer to $275 as real disposable incomes had declined. Today, as oil trades around $103 a barrel consumers "feel" like it is closer to $120.

This psychological "cost pressure" obviously impacts the way that consumers behave with their money. While the government tries to massage the differences in inflationary pressures to suppress adjustments to Social Security and Medicare; the average American is rapidly coming to grips that there is something entirely wrong with the state of affairs in the U.S. economy.

There is plenty of evidence that the economy remains mired in a state of "slow growth." The perpetual mantra from the Federal Reserve, and mainstream economists over the last three years, has been that this year will be the resurgence of economic growth. Unfortunately, each year has come and gone with the economy remaining mired at sub-par growth rates. Once soaring profitability that came at the expense of employment, and increases in productivity, has now given way to the realities of slower demand and rising cost pressures. However, such economic realities have been readily dismissed due to the ongoing central bank interventions and artifically low interest rates that have inflated asset markets since the "financial crisis."

While "Wall Street," and the top 20% of Americans that have investments, revel in the rise of "liquidity induced" financial markets; "Main Street" continues to struggle with still high unemployment, stagnant disposable incomes and increases in their costs of living. Of course, when the next "retail sales" report is released it will be important to notice just how much of the increase in sales is related to gasoline and food. What is generally missed by the mainstream analysis is that consumers are not buying MORE stuff - they are just spending MORE for it.